Payout policy

by | Aug 16, 2021 | Assignment

George Liu, the CEO of Penn Schumann was a creature of habit. Every month he and Jennifer Rodriquez, the companyâs chief financial officer, met for lunch and an informal chat at Pierreâs. Nothing was ever discussed until George had finished his favorite escalope de foie gras chaude. At their last meeting in thoughtfully with his glass of Chateau Haut-Brion Blanc before suddenly asking, âWhat do you think we should be doing about our payout policy?â Penn Schumann was a large and successful pharmaceutical company. It had an enviable list of highly profitable drugs, many of which had 5 or more further years of patent protection. Earnings in the latest 4 years had increased rapidly, but it was difficult to see that such rates of growth could continue. The company had traditionally paid out about 40% of earning as dividends, though the figure in 2008 was only 35%. Penn was spending over $4 billion a year on R&D, but the strong operation cash flow and conservative dividend policy had resulted in a buildup of cash. Pennâs recent income statements, balance sheets, and cash flow statements are summarized in Tables 17-4 to 17-6. The problem, as Mr. Liu explained, was that Pennâs dividend policy was more conservative than that of its main competitors. âShare prices depend on dividends,â he said. âIf we raise our dividend, weâll raise our share price, and thatâs the name of the game.â Ms. Rodriquez suggested that the real issue was how much cash the company wanted to hold. The current cash holding was more than adequate for the companyâs immediate needs. On the other hand, the research staff had been analyzing a number of new compounds with promising applications in the treatment of liver diseases. If this research were to lead to a marketable product, Penn would need to make a large investment. In addition, the company might require cash for possible acquisitions in the biotech field. âWhat worries me,â Ms. Rodriquez said, âis that investors donât give us credit for this and think that we are going to fritter away the cash on negative-NPV investments or easy living. I donât think we should commit to paying out high dividends, but perhaps we could use some of our cash to repurchase stock.â âI donât know where anyone gets the idea that we fritter away cash on easy living.â Replied Mr. Liu, as he took another sip of wine, âbut I like the idea of buying back our stock. We can tell shareholders that we are so confident about the future that we believe buying our own stock is the best investment we can make.â He scribbled briefly on his napkin. âSuppose we bought back 50 million shares at $105. That would reduce the shares outstanding to 488 million. Net income last year was nearly $4.8 billion, so earnings per share would increase to $9.84. If the price earnings multiple stays at 11.8, the stock price should rise to $116. Thatâs an increase of over 10%.â A smile came over Mr. Liuâs face. âWonderful, he exclaimed, âHere comes my homard a la nage. Letâs come back to this idea over dessert.â Evaluate the arguments of Jennifer Rodriquez and George Liu. Do you think the company is holding too much cash? If you do, how do you think it could be best paid out?

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